Social Innovations

Developing Native Capability

A few
years into
the 21st century,
multinational
corporations
(MNCs) find
themselves on the
horns of a dilemma.
With the unprecedented
performance of stocks over
much of recent history as a
backdrop, their shareholders now
expect double-digit returns, yet the
global economy limps along at an
annual average rate of growth of only 2-
3 percent. In addition, most large companies
seem to be mired in saturated markets, so how
will they be able to achieve high growth in the
coming years? Meanwhile, the rapid rise of global
capitalism over the past decade has been accompanied
by mounting concerns over environmental degradation,
labor exploitation, cultural hegemony, and loss of local
autonomy, particularly among developing nations. Must corporations’
quest for future growth serve only to fan the flames
of the antiglobalization movement?

The best way out of this global “Catch-22” is for MNCs to focus
on emerging markets, not the incremental market expansion targeted
at the wealthy few, but the much larger base of the economic pyramid
(BOP) – where between 4 and 5 billion people (fully two-thirds of humanity)
have been bypassed or damaged by globalization. Much like the proverbial
iceberg with only its tip in plain view, this huge segment of the global population
– along with its massive potential market – has remained largely invisible
to the corporate sector. To address this, MNCs must combine their advanced technology
and global reach with a new type of deep local understanding, based on engaging local
people. An effective combination of local and global knowledge
is needed, not a replication of the Western system. This combination
requires the development of a new capability – native
capability. As organic agriculture pioneer Wes Jackson says, we
must figure out how, once again, to become native to this place.1

The Wealth Trapped in the Underground
Economy

For the past half-century, MNCs have chosen to focus their
attention on the very tip of the world economic pyramid,
where 75-100 million highly affluent “Tier 1” consumers reside2. This is a cosmopolitan group, to be sure, composed
of upper-income people in developed countries, especially the
United States, Western Europe, and Japan, and the few rich elites
from the developing world. Initial forays into so-called “emerging
markets” – the former Soviet Union and its allies, along with
China, India, and Latin America – focused exclusively on the 800
million or so wealthy customers, ignoring the vast majority of
people considered too poor to be viable customers.

Now, with stagnation in the established markets of the world
economy and rising antiglobalization sentiments, the opportunities
for serving the huge base of the pyramid are becoming
increasingly attractive. The good news is that concealed below
the surface of the purchasing power parity numbers is an
immense and fast-growing economic system that includes a
thriving community of small enterprises, barter exchanges, sustainable
livelihoods activities, and subsistence farming.3 Indeed,
it is estimated that well over half of the total economic activity
in the developing world takes place outside the formal economy,
in the so-called informal or extralegal sector.4

The base of the pyramid is also rich in assets, although
most are unregistered, and therefore remain invisible. Indeed,
Hernando de Soto, in “The Mystery of Capital,” estimates that
there is well over $9 trillion worth of unregistered assets (e.g.,
houses, equipment, etc.) in the rural villages and urban slums
of the world.5 Because the poor typically do not hold legal title
to these assets, they remain trapped and underleveraged,
protected only by the informal property systems enforced by
local strongmen.

Becoming Indigenous: A Two-Way Street

In order to work at the base of the pyramid, large corporations
need to learn how to become “indigenous” to the places in which
they operate. Doing so will require that
they first widen the corporate bandwidth by admitting voices
that have, up to now, been excluded; it will also entail the development
of new “native” capabilities which enable a company
to develop fully contextualized solutions to real problems in ways
that respect local culture and natural diversity. When combined
with MNCs’ ability to provide technical resources, investment,
and global learning, native capability can enable companies
to become truly embedded in the local context.

The base of the pyramid presents unique challenges for
MNCs – it violates nearly every assumption associated with successfully
serving the top of the pyramid. In fact, the biggest challenge
for MNCs may have less to do with technology, intellectual
property, or rule of law, even though these issues have
dominated most of the work to date relating to emerging markets.
6 Instead, the fundamental challenge may be one of business
model innovation – breaking free of the established mindsets,
systems, and metrics that constrain the imagination of
incumbent firms. Witness Nike’s failed attempt to introduce its
“World Shoe” in the BOP.

In an attempt to stimulate growth, Nike began to produce an
athletic shoe for the booming low-income populations in China.
Based upon a relatively low price point ($10-$15 per pair), the
World Shoe was designed as a product that could appeal to the
masses who could not afford Nike’s top-of-the-line products. The
World Shoe’s failure in China can be traced, at least in part, to a
lack of empathy and inability to reconcile disconfirming information.
7

Nike’s first mistake was to rely exclusively on its existing contract
factory network to produce the product. These contract
manufacturers produced Nike’s high-end products and were
rewarded based upon contribution margin. Because of the low
price point of the World Shoe, there was a built-in disincentive
for them to produce this new product. Nike also utilized its established
in-country channels – primarily high-end retailers in
China’s large cities – to distribute the World Shoe. In fact, the
World Shoe was displayed side by side with the $150 Air Max
in upscale retail outlets in Beijing and Shanghai.

Rather than cajoling its existing contract manufacturers
and distribution channels to produce and distribute the low-end
World Shoes, Nike might have explored partnerships with
counterfeiters and other local producers. Indeed, counterfeit producers
possessed exactly what Nike lacked – production capacity
– as well as distribution capabilities to reach precisely the low-income
markets that Nike was trying to capture. Nike could have
eliminated a fierce competitor and transferred its social and environmental practices to the counterfeit producers – a win-win
for all involved. The result might have been a business model
that competes based on social capital, quality, and value for
money rather than trademark and legal protection. Instead, the
World Shoe project was shut down after failing to make even
the modest sales targets that had been set. Producing a lowercost
shoe using the existing business system meant, paradoxically,
that Nike failed to reach its target customer.

Coinvent Custom Solutions

Companies interested in developing responsive technologies and
products at the base of the pyramid can learn much from fields
such as rural sociology, applied anthropology, and empathybased
design. These disciplines stress the importance of codeveloping
custom solutions to problems through two-way information
flow. Rather than imposing preexisting solutions from
above, the emphasis is on working with local partners to codesign
every aspect of the product or service, including its delivery.

In our study of BOP ventures, Ted London and I discovered
that successful initiatives – those that became embedded in the
local community – maximized the functionality of the product
or service in terms that were important to local users. This often
meant allowing the product and business model to coevolve.
As one of our respondents indicated, successful initiatives
require “everybody who touches it to make money.”8 Poorly performing
ventures, on the other hand, tended to view the value
proposition in terms of the product itself and often completed
the development process at a geographically distant location,
such as the corporate R&D center, before the business model
was designed.

The Indian tobacco giant ITC (formerly the Imperial Tobacco
Company) was successful in marrying high-technology with traditional
economic systems in its agricultural commodities business.
ITC had purchased and exported Indian soy products for
over a century, but the inefficiencies of the agricultural system
were hindering its success. ITC exploited its knowledge of the
traditional agricultural system and modern technology to
increase the efficiency of the soy market in India, increasing
wealth throughout the entire supply chain.

The traditional agricultural system in India was centered on
mandis – the markets where farmers brought their produce to
be auctioned. Given the obvious power asymmetries (i.e., the
auctioneers had better information about commodity prices than
the farmers), small farmers were often paid far less than they
deserved for their produce. To facilitate better information
access, ITC created a soy Web site. To address the obvious
shortages – phone lines, electricity, and literate farmers – the
company has provided satellite links, solar batteries, and echoupals,
electronic meeting places run by carefully chosen
microentrepreneurs. E-choupals are a network of electronic
meeting places in over 4,000 rural villages in India.9

The e-choupals have enabled farmers to level the playing
field by gaining better access to market conditions, prices, and
even other potential buyers. By eliminating the stranglehold of
the mandis, ITC has been able to source agricultural commodities
at more favorable prices, while at the same time
increasing the bargaining power – and incomes – of the small
farmers.10 Thus, two of the big roadblocks faced by rural
economies are mitigated by e-choupals: virtual aggregation provides
bargaining power for even the smallest producers, and better
information helps overcome uncertainty and isolation.

Once the e-choupal is established in a village, there is no shortage
of other potential users: governments, putting their services
online; consumer goods firms that are otherwise unable to
reach rural villages; microcredit providers; etc. The possibilities
are virtually limitless. Thus, rather than selling a defined endproduct
such as a consumer good, e-choupals instead create the
potential for many new, perhaps unanticipated, economic activities
to blossom, driven by local needs and capabilities.

ITC intends to reach 100,000 villages with its network in the
next decade. The rural connectivity brought by initiatives such
as e-choupal could literally transform the countryside in India.
Ventures like this, which provide both in-reach and outreach,
constitute the ultimate in creation of potential. For MNCs,
therefore, identifying opportunities to create new potential
constitutes another important vehicle for reaching the BOP.

Fly Under the Radar

Avoiding dependence on central institutions – national governments,
corrupt regimes, and central infrastructure planning
– appears to be a critical aspect of native capability. By “flying
under the radar” of corruption, organizations can avoid all
the problems that go along with having to deal with difficult –
and changeable – central regimes. For example, both ApproTEC
and World Water sought to help the rural poor gain better access
to clean water. The former – which flew under the radar – is
thriving, while the latter – which worked with central regimes
– is floundering.

World Water Corporation was founded in 1984 in response
to a perceived vacuum in private business activity supplying
water and power in developing countries.11 One of its notable
products is the AquaSafe solar-powered water pump. This technology
can pump 10 times the volume of any other solar water
pump in the world – more than 2,000 gallons of water per
minute from rivers and other surface water. The technology can
also be used to pump groundwater up to 1,000 feet deep, to bring
up clean water from wells. Given that water shortages are a
major global problem, the company was confident that its
powerful solar water systems would find a big market worldwide,
and it went public in 1997.

By 2000, World Water Corporation had established operations
in 17 developing countries, including Somalia, Pakistan,
and the Philippines. Typically, the company worked through the
central government to sign long-term agreements to serve as
consultant and contractor for water and energy programs,
with a focus on rural areas.

Unfortunately, despite World Water’s best efforts, the unstable
and corrupt nature of its clients’ governments has put the
viability of the company at serious risk. The highly visible
nature of the agreements makes the scale and scope of the agreement
– and the potential profit for World Water – readily apparent
to a broad range of bureaucrats, government officials, and
others who might benefit from either derailing the project or
currying favor before it is allowed to move forward. As a result
of these problems, the company’s international business
prospects have soured considerably, and the company’s stock was
only trading at about 30 cents per share in August 2004.

By contrast, ApproTEC, a Kenya-based social venture, also
focused on water pumping in the Third World, but took a very
different approach – both technologically and in terms of business
model. ApproTEC’s MoneyMaker irrigation pump is manually
operated by small farmers and was codesigned with them
to ensure product acceptance. At under $100, the pump was
directly affordable by the end consumer, meaning that Appro-
TEC could launch its business on a small-scale basis and allow
it to grow organically over time. It bypassed the need to deal
with the central governments of Kenya and Tanzania, thereby
avoiding the types of complexity and corruption that World
Water exposed itself to. ApproTEC is now expanding across
Africa and it estimates that the additional income generated by
its water pumps equals 0.5 percent of Kenya’s gross domestic
product (GDP).12

Work With Nontraditional Partners

Companies facing challenging new environments usually need
to turn to partner organizations for missing resources and
expertise. Indeed, governments often require MNCs to have a
local corporate partner to ensure market access in emerging
economies. When entering the base of the pyramid, however,
firms may need to dramatically expand the potential field of
alliance partners since the large national players familiar with
the ways of global capitalism seldom serve the rural poor or
shantytown dwellers in their own countries.

One BOP venture in Kenya – Honey Care Africa – created
a particularly interesting three-way partnership between the private
sector, the development sector, and the local community.
The partnership exploits the core competencies of each of the
partners: the private sector’s marketing prowess, the development
sector’s social capital and microfinance expertise, and
the local community’s entrepreneurial spirit. The end objective
and reason for creating Honey Care was to make beekeeping
accessible to poor farmers, and to create a domestic source of
high-quality honey for Kenya.

Traditionally, Kenyan communities used log hives, baskets,
or clay pots for beekeeping. While cheap to set up, these crude
techniques produced small volumes of poor-quality honey.
Honey Care thus based its business model on making advanced,
yet context-appropriate beekeeping equipment available to
these small farmers. They procure and sell all of the equipment
required to establish a beekeeping enterprise – Langstroth
hives, honey harvesting kits, and honey production machines
– to a development-sector partner. In turn, this organization
leverages local social capital to provide microcredit financing to
small farmers for the purchase of the equipment. Honey Care
does not allow its development agency partners to outright
donate beekeeping equipment, as it believes that sustainable rural
development cannot be achieved via “handouts.”13

Honey Care takes many steps to ensure that all parties in the
relationship are successful. First, it requires that the farmers
receive extensive beekeeping training before receiving the
microfinance loans. By understanding how to best utilize their
new equipment, beekeepers will be more likely to have higher
quantity and quality yields. Honey Care also commits to purchasing
all of the honey produced by these farmers, guaranteeing
them a steady income and providing Honey Care with a loyal
supply of high-quality honey. Lastly, Honey Care deducts a
designated percentage of their earnings and uses it to repay the
farmers’ loans. The guaranteed income and mandatory repayment
process greatly decreases the default risk of the loans.14
Not only does the microfinance partner benefit from this lowered
risk, but the farmer is able to develop a positive credit history.
Honey Care sells the honey to distributors and retailers for
sale to end consumers.

By working with nontraditional partners who were embedded
in the local scene, Honey Care Africa has been able to
become indigenous, while leveraging its core competencies in
equipment procurement and marketing. The company has
achieved success by doubling the income of many poor farmers,
providing high-quality honey for the Kenyan market, and
creating economic, social, and environmental value for local
communities. Indeed, Honey Care is today the largest producer
of high-quality honey in East Africa.15

Build Social, Not Legal, Contracts

In the informal sectors, relationships are primarily grounded in
social – not legal – contracts, and the organizations with the most
expertise in serving these populations – local government and
civil society – have a strong social orientation. Successfully
operating in this space requires a capability to understand and
appreciate the benefits of the existing social infrastructure, not
complain about its lack of Western-style institutions.

The lending model of the Grameen Bank in Bangladesh, for
example, entails no legally enforceable instruments whatsoever.
To succeed, it was necessary for Grameen to turn most of the
established assumptions about banking (e.g., loan size, need for
collateral, contractual enforcement) upside down. Grameen
instead focused on making very small loans to poor women
based upon a “peer lending” model where small groups of
loan recipients became mutually responsible for each others’
credit. Since there is no collateral, legal papers would be useless.
If a borrower defaults, bank staff work with her to restructure
the debt or plan an alternative repayment schedule. The
entire business model is based upon social capital and trust.

By the late 1990s, Grameen was lending in excess of $250
million each year to more than 2.3 million poor customers in
over 40,000 villages throughout Bangladesh. Even more amazing,
it achieved a 95 percent repayment rate, the highest of
any bank on the Indian subcontinent, and indeed much higher
even compared to North American and European banks in
the United States. The imagination of the Grameen Bank has
led to a global explosion of institutional interest in microlending
over the past decade, including the recent entry of financial
giants such as Citigroup.

Moving Beyond the Transnational Model

For MNCs to flourish in the 21st century, it appears that they
must expand their conception of the global economy to include
the varied economic activities that occur outside of the formal,
wage-based economy. They must embrace the informal, barter,
and household economies and tailor their business models to
enhance the way people currently live. In partnership with
local entrepreneurs, NGOs, and local governments, MNCs can
help build a system of governance from the ground up, rather than
waiting for corrupt central governments to reform.

Native capability enables the corporation to become truly
embedded – part of the local landscape – rather than an alien force
that imposes its will from the outside. Embeddedness takes time
to develop and cannot be quickly duplicated by competitors.
Competitive advantage is then based upon deep understanding
of and integration with the local environment. Companies
earn it by creating a web of trusted connections with a diversity
of organizations and building on the available social infrastructure.
Rather than looking to overcome limitations in the
environment – lack of central institutions, rule of law, etc. –
native capability emphasizes the crafting of strategies that build
on existing conditions and resources.

Unlike the conventional transnational model, which focuses
on transferring proprietary resources from within the firm,
native capability assumes that the critical knowledge for success
lies beyond the firm’s boundaries. MNCs, not their local partners,
are the ones that must do the unlearning. Given that, competitive
advantage is premised less on protecting existing proprietary
technology or intellectual property, and more on
developing trust and social capital. Generic principles and learnings
from specific settings, however, can and must be transferred
and applied in other BOP contexts – that is how the capability
is fostered and spread. The time has come for MNCs to move
beyond the traditional conception of transnational success.
And developing native capability is one of the keys to creating
a truly sustainable global enterprise.

STUART L. HART is the S.C. Johnson Chair of Sustainable Global
Enterprise and professor of management at Cornell University’s Johnson
Graduate School of Management. He received his Ph.D. from the University
of Michigan. His research interests center on strategy innovation and
change, particularly the strategic implications of environmentalism and
sustainable development. He can be reached at [email protected]TED LONDON is on the faculty at the University of North Carolina’s
Kenan-Flagler Business School. In July 2005, he will move to the University
of Michigan, where he will teach at the Ross School of Business, and
lead a new base of the pyramid research initiative at the William Davidson
Institute. His research focuses on strategic growth and change, including
capability development for emerging markets and cross-sector
alliances between corporations and nonprofit organizations. He can be
reached at [email protected]

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